Determinants of Profitability of Banks in India: A Multivariate Analysis

Determinants of Profitability of Banks in India: A Multivariate Analysis

Article excerpt

Banking Sector Reforms have changed the face of Indian banking industry. The reforms have led to the increase in resource productivity, increasing level of deposits, credits and profitability and decrease in non-performing assets. However, the profitability, which is an important criteria to measure the performance of banks in addition to productivity, financial and operational efficiency, has come under pressure because of changing environment of banking. An efficient management of banking operations aimed at ensuring growth in profits and efficiency requires up-to-date knowledge of all those factors on which the bank's profit depends. Accordingly, in this paper we have made an attempt to identify the key determinants of profitability of Public Sector Banks in India. The analysis is based on step-wise multivariate regression model used on temporal data from 1991-92 to 2003-04. The study has indicated that the variables such as non-interest income, operating expenses, provision and contingencies and spread have significant relationship with net profits.

INTRODUCTION

Since the initiation of economic reforms in 1991-92, the banking sector in India has seen numerous developments and policy changes. The more important reforms initiated in the banking sector includes adoption of prudential norms in terms of capital adequacy, assets classification and provisioning, deregulation of interest rates, lowering of Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR), opening of the sector to private participation, permission to foreign banks to expand their operations through subsidiaries, the introduction of Real Time Gross Settlement (RTGS) and liberalization of FDI norms. The main thrust of the banking sector reforms has been the creation of efficient and stable financial institutions and development of the banking industry. The reforms have been undertaken gradually with mutual consent and wider debate amongst the participants and in a sequential pattern that is reinforcing the overall economy.

Introduction of banking sector reforms have changed the face of Indian banking industry. The national, institutional and international boundaries are becoming less important. The globalization of operations and development of new technologies are taking place at a rapid pace. A paradigm shift in marketing philosophy of banks is visible from the rising focus towards quality of service for customers. All this has led to the increase in resource productivity, increasing level of deposits, credits and profitability and decrease in nonperforming assets (Charan Singh, 2005). The statistics on important indicators of the performance of Banking Industry in India as exhibited in Table-1 reflect an appreciable growth of banks. The table also gives a hint that the public sector banks still dominates the scene of banking in India.

However, the banks are now facing a number of challenges such as frequent changes in technology required for modern banking, stringent prudential norms, increasing competition, worrying level of NPA's, rising customer expectations, increasing pressure on profitability, assets-liability management, liquidity and credit risk management, rising operating expenditure, shrinking size of spread and so on. The reforms in banking sector have also brought the profitability under pressure. RBI's efforts to adopt international banking standards have further forced the banks to shift the focus to profitability for survival. Hence, profitability has become major area of concern for bank's management. Infact, profit is an important criteria to measure the performance of banks in addition to productivity, financial and operational efficiency.

An efficient management of banking operations aimed at ensuring growth in profits and efficiency requires up to date knowledge of all those factors on which the bank's profit depends. This is only possible through research studies conducted by researchers, economists and analysts. …